AIP Client Advisory & Ethical Practices 2 — Questions and Answers
Question 1: An investment advisor discovers that a client's portfolio concentration in a single sector now exceeds the client's stated risk tolerance due to market appreciation. What is the advisor's MOST appropriate immediate action?
- Ignore the drift since it resulted from gains, not purchases
- Contact the client to discuss rebalancing options and document the conversation (Correct answer)
- Rebalance immediately without contacting the client to protect their interests
- Wait until the next scheduled annual review to address the concentration
Correct answer: Contact the client to discuss rebalancing options and document the conversation
Advisors must proactively communicate when portfolios deviate from stated objectives and document all client interactions.
Question 2: Under the AIP ethical framework, which of the following BEST describes the 'duty of loyalty' owed to clients?
- Recommending products that generate the highest advisor compensation
- Placing client interests ahead of personal or firm interests at all times (Correct answer)
- Maintaining loyalty to the firm's proprietary investment products
- Prioritizing long-term client relationships over short-term suitability concerns
Correct answer: Placing client interests ahead of personal or firm interests at all times
The duty of loyalty requires advisors to always put client interests first, subordinating personal and firm interests.
Question 3: A client asks an AIP-certified advisor to recommend an investment that guarantees a 15% annual return with no risk. The advisor's BEST response is to:
- Recommend high-yield bonds as a close alternative
- Explain that no legitimate investment guarantees such returns without risk (Correct answer)
- Refer the client to another advisor who may know of such products
- Document the request and search for the highest-yielding product available
Correct answer: Explain that no legitimate investment guarantees such returns without risk
Advisors must educate clients about realistic return-risk relationships and cannot represent guaranteed high returns.
Question 4: When must an investment advisor provide a client with a Form ADV Part 2 brochure?
- Only when the client specifically requests it
- At least 48 hours before entering into an advisory agreement (Correct answer)
- Annually, regardless of whether there are material changes
- Only upon initial account opening and never again unless requested
Correct answer: At least 48 hours before entering into an advisory agreement
SEC rules require delivery of the Form ADV brochure at least 48 hours before entering an advisory contract or at the time of signing if the client has the right to cancel within five days.
Question 5: A client's investment policy statement (IPS) specifies no investments in tobacco companies. The advisor inadvertently purchases tobacco sector ETFs. Under ethical practice standards, the advisor should FIRST:
- Liquidate the position immediately and inform the client after the fact
- Inform the client promptly, explain the error, and discuss corrective action (Correct answer)
- Wait to see if the position appreciates before deciding whether to disclose
- Transfer the position to another client account to avoid reporting the error
Correct answer: Inform the client promptly, explain the error, and discuss corrective action
Prompt, transparent disclosure of errors and collaborative corrective action is required under professional ethics standards.
Question 6: Which scenario MOST clearly constitutes churning under securities regulations?
- An advisor rebalances a portfolio once annually to maintain target allocations
- An advisor executes frequent trades primarily to generate commissions with little client benefit (Correct answer)
- An advisor moves a client from mutual funds to ETFs to reduce expense ratios
- An advisor completes multiple trades during a volatile market to reduce client losses
Correct answer: An advisor executes frequent trades primarily to generate commissions with little client benefit
Churning is excessive trading primarily to generate commissions rather than to benefit the client's investment objectives.
Question 7: An advisor receives a referral fee from a third-party service provider for recommending the provider's services to clients. Under ethical practice, the advisor MUST:
- Decline all referral arrangements to avoid conflicts of interest
- Disclose the referral fee arrangement to clients before making the recommendation (Correct answer)
- Report the fee only to the compliance department, not to clients
- Accept the fee only if it is under a materiality threshold of $100
Correct answer: Disclose the referral fee arrangement to clients before making the recommendation
All compensation arrangements that create potential conflicts of interest must be disclosed to clients.
AIP Client Advisory & Ethical Practices 2
An investment advisor discovers that a client's portfolio concentration in a single sector now exceeds the client's stated risk tolerance due to market appreciation.
What is the advisor's MOST appropriate immediate action?